ACCN 2010 Exam 2 Study Guide
ACCN 2010 Exam 2 Study Guide ACCN 2010
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This 9 page Study Guide was uploaded by Tara Watkins on Sunday March 13, 2016. The Study Guide belongs to ACCN 2010 at Tulane University taught by Christine Smith in Spring 2016. Since its upload, it has received 97 views. For similar materials see Financial Accounting in Accounting at Tulane University.
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Date Created: 03/13/16
Accounting 2010 Exam 2 Study Guide Merchandisers are entities that buy/sell merchandise to earn a profit instead of performing services to earn a profit. o Types of merchandisers: Wholesalers – sell to retailers Retailers – sell to consumers A merchandiser’s main revenue source is sales revenue (selling products to either a retailer or consumer). Two types of expenses are incurred by merchandisers: o Cost of Goods Sold and Operating Expenses Entities want the operating cycle to occur as often as possible because if it doesn’t: o Products in their inventory could become obsolete (ex. outdated technology, clothes that have gone out of style or are out of season). o Their investments (assets) are tied up and cannot raise revenue (ex. having $1,000 worth of products in a stockroom is an unused potential economic benefit but they cannot earn a profit until they are sold). Companies can choose to use one of two inventory systems: o Perpetual inventory system Records every sale. Always have access to the amount of inventory that should be available for sale (may not be 100% accurate due to theft (AKA shrinkage)). Taking a physical count of the inventory and comparing it to what the system says should be on hand will reveal if shrinkage has occurred. Cost of Goods Sold is determined when each sales happens. Commonly used. More expensive than the periodic system because of the computer systems necessary. o Periodic inventory system Records the amount of inventory at the beginning of the period. Determines the Cost of Goods Sold (COGS) at the end of the period. COGS = Beginning inventory + net purchases – ending inventory More common in small businesses because it’s cheaper and their inventory is small enough to manage without constant monitoring. Multi-step income statement o Used to calculate Key Performance Indicators (KPI) which are intermediary measures of success. o KPIs are: Gross Profit (Gross Profit = Net Sales - Cost of Goods Sold) Operating Income (Operating Income = Gross Profit – Operating Expenses) Net Income (Net Income = Operating income + sum of all non-operating revenues/expenses) o Gross Profit rate = gross profit ÷ net sales Ex. 3,000 ÷ 9,000 = 33.3% This is useful because it shows the relationship between gross profit and net sales. The greater the rate, the profitable the company is. o Example format: Revenue: Merchandise Sales $ 10,000 Sales Discounts < 500 > Sales Returns and Allowances < 750 > Net Sales 8,750 Cost of Goods Sold < 5,500 > Gross Profit 3,250 Operating Expenses < 900 > Operating Income 2,350 Other Revenues and Expenses (can be + or -) 650 Income Before Income Taxes 3,000 Income Tax Expense < 800 > Net Income $ 2,200 Freight Costs o FOB stands for Free on Board. o FOB shipping point – buyer pays the freight costs because ownership transfers when the goods are passed to the shipping carrier. o FOB destination – seller pays the freight costs because ownership transfers when the goods are delivered to the buyer. o When the buyer pays freight costs, inventory is increased because the cost of inventory includes all costs to get the items to their final destination for sale. o When the seller pays freight costs, an expense account called Freight-Out is increased. Purchase Returns and Allowances o Purchase return – when a buyer sends damaged or unsatisfactory goods back to the seller for a refund or credit. Buyer would decrease inventory (credit) and decrease accounts payable (debit). o Purchase allowance – when a seller reduces the price of an unsatisfactory good and the buyer keeps the item. Purchase discounts o Ignore trade discounts (ex. an item listed at $100 but advertised on sale for $50). o Pay attention to cash discounts which are listed on invoices. Ex. 2/10, n/60 – this means that if you pay within 10 days, you receive a 2% discount. If you pay after the 10 day period is over, you owe the full amount within 60 days. If the full amount was $1,000 and you paid it within the first 10 days, you would only pay $980. But if you paid it after the 10 days were over, you would pay $1,000. This is recorded by the buyer as: $1,000 debit to Accounts Payable $980 credit to Cash $20 credit to Inventory Sales Returns and Allowances o Sales Returns and Allowances and Sales Discounts are contra-revenue accounts for Sales Revenue. o Sales return - when a seller receives damaged or unsatisfactory goods from a buyer for a refund or credit. Seller would increase Sales Returns and Allowances (debit) and decrease accounts receivable (credit). Seller would also increase inventory (debit) and decrease Cost of Goods Sold (credit). o Sales allowance - when the buyer keeps the unsatisfactory good but the seller reduces the price of the item. Seller would increase Sales Returns and Allowances (debit) and decrease accounts receivable (credit). Sales Discounts o Same as purchase discounts (the difference is that sales discount is the name used by the seller instead of the buyer). Ex. 2/10, n/60 – this means that if the customer pays within 10 days, they receive a 2% discount. If they pay after the 10 day period is over, they owe the full amount within 60 days. If the full amount was $1,000 and they paid it within the first 10 days, they would only pay $980. But if they paid it after the 10 days were over, they would pay $1,000. This is recorded by the seller as: $980 debit to Cash $20 debit to Sales Discounts $1,000 credit to Accounts Receivable In periodic inventory systems, entries are slightly different than in the perpetual inventory system. o For buyers: When purchases are made, debit Purchases instead of Inventory account. When freight costs are incurred, debit Freight-In instead of Inventory account. When purchases are returned or allowances are granted, credit Purchase Returns and Allowances instead of Inventory. When a purchase discount is offered and taken, credit Purchase Discounts instead of Inventory. o For sellers: When sales are made, only an entry debiting Accounts Receivable and crediting Sales Revenue is recorded. When sales are returned or allowances are granted, only an entry debiting Sales Returns and Allowances and crediting Accounts Receivable is recorded. When a sales discount is offered and taken, Cash and Sales Discounts are still debited and Accounts Receivable is still credited. To determine how inventory is valued, 3 factors must be considered: o 1. Physical goods Goods in transit – determine who has ownership in transit? FOB destination – buyer does not have ownership until its delivered FOB shipping point – buyer has ownership as soon as it is shipped o 2. Costs that are included in the cost of inventory Product costs Any cost that is necessary to get the goods to the destination in the condition necessary for sale (ex. item cost, shipping costs (depending on shipping terms), taxes, insurance (during transport), refrigeration costs (if necessary), etc.) o 3. Cost Flow Assumptions (One of the four) Specific Identification FIFO (First In, First Out) LIFO (Last In, First Out) Weighted Average Period costs are not included in capital, only expensed in the period incurred Each of the 4 Cost Flow Assumptions will return a different amount for: o Inventory o Cost of Goods Sold o Net Income GAAP does NOT require the cost flow assumption pattern to match what actually happens o Ex. a company can sell its newest products first and still use the FIFO assumption if they choose to An entity must choose which cost flow assumption they are going to use o For Specific ID cost flow assumption, each item has to have an ID unique to its cost (items that cost $10 would have a different ID than items that cost $5) Advantage: There is no guessing involved, the ID on the item tells us exactly what price it was purchased for Disadvantages: Can be very expensive to track each item Can be impossible in some cases to track each item Management could manipulate earnings by selling cheaper items at higher costs o For FIFO, the earliest (oldest) purchases are the first products sold Advantages: Higher gross profit Disadvantages: Higher income tax expense Higher checks that are paid to employees o For LIFO, the latest (newest) purchases are the first products sold Advantages: Lower income tax expense Lower checks that have to be paid to employees Disadvantages: Lower gross profit o For weighted average, the results are between those of FIFO and LIFO A receivable is a future economic benefit (asset) or claim to cash from an external party (or in simpler terms, payments owed to the company) o There are 3 types of receivables: 1. Accounts receivable – spoken promise to pay AKA – trade receivables 2. Notes receivable - written, legally contractual promise to pay In some cases, notes receivable are trade receivables (if it resulted from a sales transaction) 3. Other receivables Ex. interest, income tax refund, paycheck advances to employees (only happens in small companies) o GAAP requires receivables to be recorded separately on the balance sheet o There are 2 possible issues that can occur when dealing with receivables: 1. Recording the receivable properly Ex. when following the Revenue Recognition Principle, make sure that the revenue is recorded when it is earned not when it is paid for 2. Valuing the receivable The amount owed might not be paid in full or paid at all o Management is responsible for determining how much of the value of the products/services sold they expect will be paid for o Net realizable value – net amount that a company expects to receive from the sale of receivables o Allowance method – a way to estimate how much that is owed to the company will not be paid o Direct write-off method – the company waits until it is clear that a customer is not going to pay what they owe and then debits an account called Bad Debt Expense and credits Accounts Receivable for the amount owed Does not follow the matching principle Okay to use in small, non-public companies if their receivables are not material or important to the balance sheets o Allowance methods: Percentage of sales (Income Statement) method Percentage of receivables (Balance Sheet) method Long term assets o Are used in company operations to earn revenue o Have a useful life of more than 1 year o Are not considered current assets (long term assets are a separate category) 3 types of long term assets o Plant assets (ex. building, land, machinery, equipment, etc) Could also be called fixed assets or Property, Plant and Equipment Tangible assets o Natural resources Tangible assets o Intangible assets (ex. copyrights, patents, trademarks, etc) Correctly classifying assets is important to creating accurate classified balance sheets Classified balance sheets have to be correct so that ratios can be calculated and the information obtained can be used to make informed decisions o Land purchased speculatively (not used, saved for future use) is categorized as a long term investment o Land purchased by a company to help them earn revenue (builders, real estate companies) is categorized as inventory 4 accounting issues related to Property, Plant, and Equipment o Acquisition – accounting for a new item o Utilization – allocation of costs o Subsequent Expenditures – expenses related to the item o Disposition – sale, retirement, or death of the item GAAP says to capitalize all costs of acquisition involved in getting it to its condition and location for use --- similar to GAAP’s inventory cost rules o Under equipment, debit: Invoice price Processing fees FOB shipping point Taxes Insurance (during transportation) Assembly Unpacking Installation Door widening (if necessary to get equipment to the desired location for use) Testing costs o The total capitalized costs are allocated to an expense account (Depreciation account) As long as management has a systematic and practical approach, they can choose which method of depreciation to use o In order to decide on a depreciation method, management needs to know: Estimated useful life/Estimated Units of Production This estimation can vary depending on management’s plans for usage of the item Salvage value (scrap value – how much we could get for the equipment at the end of its useful life) 3 most common depreciation methods o Straight Line Method Time based o Declining Balance Method Time based o Units of Production Method Activity (Production) based Each depreciation method yields different amounts No matter which method is chosen, while varying each year, the same amount of costs will be allocated by the end of the equipment’s estimated useful life Straight Line Method o S/L = Depreciable Base x (1/estimated useful life) Depreciable base = historical cost - salvage value If the historical cost of a new commercial oven with an estimated useful life of 5 years was $17,000 and its salvage value was $2,000, then its depreciable base would be $15,000. ($17,000 – 2,000 = $15,000) 1/estimated useful life is also called the straight line rate Assuming the same data and depreciable base as above, the S/L would be: $15,000 x (1/5) = $3,000 <- depreciation expense So therefore each year, we would debit the Depreciation expense account by $3,000 and credit the contra-asset account Accumulated Depreciation Expense Each year, the net book value of the equipment decreases by the depreciation amount (in this case, it decreases by $3,000 every year) Ex. year 1 – Acc. Dep. Exp = 3,000, net book value = 14,000 year 2 – Acc. Dep. Exp = 6,000, net book value = 11,000 year 3 – Acc. Dep. Exp = 9,000, net book value = 8,000 year 4 – Acc. Dep. Exp = 12,000, net book value = 5,000 year 5 – Acc. Dep. Exp = 15,000, net book value = 2,000 Net book value does NOT equal fair value (what you would get if you sold the equipment at a certain time) This is not a valuation process, it is simply a cost allocation process At the end of the equipment’s estimated useful life, the book value should never be lower than its salvage value Advantage: Easy to calculate Disadvantage: Does not follow the matching principle very well Declining Balance Method o Decl. Balance = Book value x ? x S/L rate ? is a number set by management Using the same numbers as earlier (starting book value of $17,000, salvage value of $2,000 and an estimated useful life of 5 years) and a ? value of 2, the declining balance would be: Year 1 = 17,000 x 2 x 1/5 = 6,800 <- Dep. Exp. Acc. Dep. Exp. = 6,800, net book value = 10,200 Year 2 = 10,200 x 2 x 1/5 = 4,080 <- Dep. Exp. Acc. Dep. Exp. = 10,880, net book value = 6,120 Year 3 = 6,120 x 2 x 1/5 = 2,448 <- Dep. Exp. Acc. Dep. Exp. = 13,328, net book value = 3,672 Year 4 = 3,672 x 2 x 1/5 = 1,468.80 <- Dep. Exp. Acc. Dep. Exp. = 14,796.80, net book value = 2,203.20 *Year 5 In this example, in year 5, the depreciation expense calculated would cause the book value to be below the salvage value. Since this is not allowed to happen, we would just record the depreciation expense of $203.20 which would make the net book value $2,000 (equal to the salvage value). Advantage: Follows the matching principle well Disadvantage: If there is remaining estimated useful life left after you reach the point when the accumulated depreciation expense equals the depreciation base (in the example above, this does not occur but if it did, it would be $15,000), then it does not follow the matching principle well because in those years, you are reporting $0 in depreciation expenses. Units of Production Method o Units of production = depreciation base x (actual production/estimated production) Estimated Production is 10,000, year 1 actual = 3,000, year 2 actual = 2,000, year 3 actual = 1,500, year 4 actual = 4,500, year 5 actual = 2,400 Ex. Year 1 = $15,000 x (3,000/10,000) = 4,500 – Dep. Exp. Acc. Dep. Exp. = 4,500, net book value = $12,500 Year 2 = $15,000 x (2,000/10,000) = 3,000 – Dep. Exp. Acc. Dep. Exp. = 7,500, net book value = $9,500 Year 3 = $15,000 x (1,500/10,000) = 2,250 – Dep. Exp. Acc. Dep. Exp. = 9,750, net book value = $7,250 Year 4 = $15,000 x (4,000/10,000) = 6,000 – Dep. Exp. **this calculation would make the Acc. Dep. Exp. higher than the depreciation base and the net book value lower than the salvage value so the actual depreciation value for year 4 that would be reported would be $5,250. In year 5, no depreciation expense would be reported because the oven has already been fully depreciated. A different result is reported each year based on production Advantage: Follows the matching principle very well if revenue matches production (if what is made sells)
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